2009 - First Half Results


The property/casualty (P/C) insurance industry reported an annualized statutory rate of return on average surplus of positive 2.5 percent during the first half of 2009, down from 5.5 percent for the first half of 2008 but up from negative 1.2 percent during the first quarter of 2009 and positive 0.5 percent for all of 2008. Negative first-quarter profitability was more than offset by a 6.3 percent return on average surplus during the second quarter. The results provide the first evidence of a rebound in profitability for property/casualty insurers in the wake of the financial crisis that began in mid-2007. The industry’s profitability was pulled back into positive territory primarily by a 60 percent reduction in realized capital losses, which shrank to $3.2 billion in the second quarter from $8.0 billion in the first, reflecting improved stock and bond market conditions during the second quarter. Secondary factors included improved underwriting conditions, with the second-quarter combined ratio falling to 99.5 from the first quarter’s 102.2, leaving the first half combined ratio at 100.9.

In another sign of recovery, capacity in the industry (as measured by policyholders’ surplus) rebounded for the first time in two years. Policyholders’ surplus increased by $25.9 billion or 5.9 percent to $463.0 billion during the second quarter from $437.1 billion at the end of the first quarter. This reversal is notable and important. Property/casualty insurance industry capacity had plunged by an alarming $84.7 billion or 16.2 percent over the previous five quarters from the pre-crisis peak of $521.8 at the end of the second quarter of 2007. The recovery of asset markets, while welcome, should be viewed only as leading indicators of economic recovery. Rising stock and bond prices do nothing to salve the impact of the ongoing five-year-old soft market or to reverse the significant reduction in demand for insurance driven by a deep global recession that has destroyed property and liability exposure on a worldwide scale. The weak pricing environment and the sharpest contraction in the economy since 1982 sent net written premiums tumbling by 4.2 percent. The industry results were released by ISO and the Property Casualty Insurers Association of America (PCI).

The Financial Crisis: A Parting of the Clouds in the “Perfect Storm”

Profitability Begins to Recover but Remains Woefully Inadequate

The global financial crisis that sent the world economy into a tailspin over the past two years has at last begun to loosen its grip. In the United States, Federal Reserve Chairman Ben Bernanke recently declared in September 2009 that “the recession is very likely over.”  While Mr. Bernanke’s declaration is comforting, the fact that the recession is over in a technical sense does not portend a period of unbridled growth and prosperity. The wounds inflicted on the U.S. and global economies are deep and in some cases permanent. New growth will sprout from the ashes but only after a slow and fitful recovery. For property/casualty insurers and reinsurers it will take two to three years simply to replace the exposure that has been lost since the onset of the crisis in mid-2007. The recovery in financial markets notwithstanding, the global economy actually continued to shrink during the second quarter, with inflation-adjusted GDP growth in the U.S. shrinking by 1 percent.
It must be understood that the profit recovery in the property/casualty insurance industry during the second quarter had nothing to do with improvements in the “real” (i.e., goods and service producing) economy. As stated previously, the swing to positive profits was first and foremost due to an end of the financial panic that sent stock markets into a freefall following the failure of Lehman Brothers in September 2008. The subsequent seizure of credit markets and rising concerns over defaults pushed bond prices down sharply, causing significant realized and unrealized capital losses on insurer portfolios. With two-thirds of invested assets held in the form of bonds, P/C insurer capacity is highly sensitive to changes in credit market conditions.
Net income after taxes (profit) during the first half totaled $5.8 billion. The profit was earned entirely in the second quarter, with net income of $7.1 billion more than offsetting the $1.3 billion loss recorded during the year’s first quarter. As mentioned earlier, the impact was to push the industry’s return on average surplus to positive 2.5 percent, up from negative 1.2 percent during the first quarter. The continued stock market rally and healing of the credit markets during the third quarter boded well for insurer profitability during the second half of 2009.
The current profit recovery must be kept in perspective. While net income is once again positive, a 2.5 percent rate of return is woefully inadequate by any standard. The US property/casualty insurance industry’s equity cost of capital stood at approximately 10.5 percent during the first half of 2009. This means that there is an 8 percent gap between the rate of return that investors in the industry expect to earn given the risks they are being asked to assume and the industry’s actual return of 2.5 percent in the first half of 2009. Failure to earn the cost of capital over an extended period of time could result in the exit of capital and, more importantly, difficulty in raising capital after a major “capital event,” particularly in the current capital constrained environment.

Investment Performance: The Principal Cause of Volatility in 2009 Profits and Capacity

The economic crisis continues to affect P/C insurer profitability primarily through reduced investment earnings—one of only two sources of revenue for insurers (the other being premium income). Insurers are among the largest institutional investors in the world, with P/C insurers managing assets totaling some $1.2 trillion as of year-end 2008. Earnings on investments fall into several categories, the largest being investment income (primarily interest generated from bond holdings and dividends from stocks). Capital gains are the second most important source of investment earnings. Both were down significantly during the first quarter of 2009. Given the scant 1.8 percent increase in the Standard & Poor’s (S&P) 500 Index during the first half and generally weak credit market conditions, it is no surprise that the opportunity to realize net capital gains on stock and holdings effectively vanished. As noted by ISO and PCI, realized capital gains were nonexistent in the first half—with the industry instead turning in a record first-half realized capital loss of $11.2 billion, compared with a relatively small $1.1 billion loss during the same period in 2008. For all of 2008, the P/C insurance industry recorded a $19.8 billion realized loss on investments. The $31.0 billion in realized capital losses since the beginning of 2008 is by far the largest in the industry’s history, dwarfing the $1.2 billion loss in 2002 in the wake of the tech bubble collapse and the market crash following the September 11, 2001 terrorist attacks.
It is worth noting once again, however, that the magnitude of realized losses is diminishing. The industry’s second quarter realized capital losses totaled $3.2 billion, down 60 percent from $8.0 in the second quarter.
There are several reasons to believe that the worst might be behind the industry in terms of realized investment losses. First, major stock market indices are well off their March 2009 lows. The S&P 500 Index, for example, was up 35.9 percent through June 30 from its March low (and up 55 percent through September 25). Moreover, any future plunge in stock markets or loss of value in troubled credit instruments, should they occur, will have a much more muted impact on investment earnings because insurer portfolios have been substantially “derisked” over the past two years. That is because plunging share prices between late 2007 and early 2009 reduced equity exposure. The share of the industry’s portfolio invested in common stock shrank from 17.7 percent at year-end 2007 to approximately 14.9 percent as of year-end 2008. In addition, insurers have shifted assets into more conservative investments including U.S. Treasury securities and cash.

Declining stock prices were not the only reason for the plunge in realized capital gains. Beyond the market swoon is the fact that insurers had to write off or write down billions of dollars in assets. Assets in this case include not only stocks but credit instruments such as bonds and collateralized debt obligations that have lost value. The recovery in credit markets has allowed insurers to take favorable “marks” (record increases in value) on some securities.

Interest rates on the safest of assets plunged in late 2008 and remained low during the first quarter, reducing the ability to generate investment income in the future. The Federal Reserve had cut its key federal funds rate on multiple occasions last year. At the beginning of 2008, the federal funds rate was 4.25 percent. In December 2008 the Fed cut rates below 1.00 percent for the first time ever, targeting a range between zero and 0.25 percent, where they remained throughout the first and second quarters of 2009. Because the Fed has now lowered the interest rates it controls effectively to zero, it has essentially reached the limits of what it can do to stimulate the economy by reducing borrowing costs, the traditional anti-recessionary policy prescription administered by the Fed for decades. The Fed has not been rendered impotent, however. Chairman Bernanke has engaged the Fed in a strategy known as “quantitative easing,” which means that it is purchasing agency debt (such as debt issued by Fannie Mae and Freddie Mac) as well as longer-dated Treasury securities. Both efforts had the effect of pushing down longer-term interest rates during the first half of 2009 in an effort to stimulate mortgage lending and capital investment, thereby adding to the economic stimulus of traditional interest rate policy. Through the first half of 2009 continued low long-term interest rates provided clear evidence that the Fed’s new strategy was successful.

Interest rates are also being held down by the lack of inflationary expectations. While there has been concern that the Obama Administration’s $787 billion economic stimulus program, combined with the Federal Reserve’s ballooning balance sheet would put inflationary pressure on the economy, there remains no inflation on the horizon. High unemployment, low factory utilization and the bursting of last year’s energy and commodity price bubble mean that there is plenty of slack in the system to absorb growth without sparking inflation. One of the best measures of inflationary expectations is the yield on intermediate and long-dated Treasury securities. As of late September, the yield on U.S. Treasury securities stood at 3.5 percent while the yield on 30-year bonds was 4.2 percent. Neither suggest a great deal of concern on the part of investors about inflation. Moreover, the Federal Reserve is highly cognizant of the risk and is already looking at the timing of dimensions for partial withdrawal of its monetary stimulus.  

Lower interest rates are an important consideration for insurers. As large as the realized capital losses are, capital gains (losses) generally constitute a smaller proportion of investment earnings than investment income, which decreased by 9.3 percent ($2.4 billion) during the first half. The decline, while expected, is disconcerting for several reasons. First, the drop represents the continuation of a trend that began in 2008 when investment income fell 7 percent to $51.2 billion from $55.1 billion in 2007. Second, the decline in investment income is accelerating—from 7 percent in 2008, to 9.3 percent through the first half of 2009. Although net investment income—at $23.6 billion during the first half—remains a substantial source of earnings—it is no longer sufficient to propel the industry to a profit in light of rising realized capital losses and continued losses from underwriting. The decline in investment income during the first quarter is largely attributable to lower interest rates as well as lower cash flows and decreasing stock dividends.

Stock Dividends: The Long-Term Casualty of the Financial Crisis

One often overlooked component of investment income that is also taking a nose dive is stock dividends. Many dividend paying blue chip companies reported poor earnings in 2008 and the first half of 2009. Consequently, a record number of companies announced dividend cuts during the first half of this year, according to Standard & Poor’s. It was the first time that dividend cuts outpaced dividend increases since the S&P began tracking dividend payouts in 1955. Because insurers are among the largest institutional investors in the United States, the loss of so much dividend income will have a meaningful impact on investment earnings on an industrywide basis (though the effects will vary from insurer to insurer). Standard and Poor’s predicted earlier this year that dividends paid by S&P 500 companies would fall 22.6 percent in 2009, second only to 1938 when dividends plunged 36.3 percent.


What Do Reduced Investment Earnings Mean for P/C Insurers?

The combination of low interest rates, depressed asset prices and smaller dividends means that P/C insurers are earning less from their investment portfolios than in the past. The implications are both profound and immediate because there can be no guarantee of a reversal in these trends. The only guarantee is that insurers will continue to face losses from claims that are as large as or larger than in the past. The bottom line, therefore, is that insurers will need to earn more in premium through higher rates to compensate for lower investment earnings. All else being equal, robust investment returns allow insurers to charge less than they would otherwise need to charge. Investment earnings are factored into rate need expectations. Buyers of insurance and regulators will have to accept the fact that insurers will need to charge higher rates in order to meet expected losses that are little changed despite the recession and depressed investment environment. Had a major hurricane struck the coast of Florida during the 2009 hurricane season it would have cost no less and probably more than the same storm before the crisis. In the future, more of those losses will necessarily be paid through premiums and less from investment earnings. 
A concrete way to demonstrate the importance of sound underwriting and pricing in the current investment climate comes from an historical examination of periods of similar underwriting performance relative to profitability. During the first half of 2009, the industry’s combined ratio of 100.9 resulted in a 2.5 percent return on average surplus. In 2008, the industry’s 101.0 combined ratio (excluding mortgage and financial guaranty insurers) produced a 4.2 percent return. In 2005, the combined ratio was 100.7 while the return was even higher at 9.6 percent. Back in 1979, the industry’s combined ratio was 100.6 while the overall return was 15.9 percent. Given that the underwriting performance in each of these years was virtually identical, what explains the radically different profitability figures? The answer is the investment environment and the prevailing level of interest rates in particular. Lower interest rates, which are becoming imbedded in insurer portfolios as higher yield bonds mature and are replaced with lower yielding securities, make it extremely difficult if not impossible for most insurers to earn a risk appropriate rate of return without improving their underwriting performance through increased rates, lower claims cost or lower expenses or some combination of the three.     

Underwriting Performance: Discipline or Good Fortune?

Profits during the first half were hurt by a modest underwriting loss of $2.2 billion after policyholder dividends on a combined ratio of 100.9. Yet the underwriting performance is better than the 102.0 recorded during the same period in 2008. Most notable was the improvement in the second quarter. At 99.5, the industry managed to turn a small underwriting profit ($382 after dividends) compared to a $5.1 billion underwriting loss on a much higher combined ratio of 104.1 during the second quarter of 2008. 
Weakness in commercial lines pricing remains the greatest challenge to industry underwriting performance. One break that insurers caught during the first half came from notably lower catastrophe losses, which fell by 29.2 percent to $7.5 billion from $10.6 billion in the year earlier period, according to ISO’s PCS unit (details below).

Mortgage and Financial Guaranty Insurers Distort Results

It is important to bear in mind that the 2009 results remain somewhat skewed by the disastrous performance of many mortgage and financial guaranty insurers. This segment accounts for just 2 percent of industry premiums written but ran a combined ratio of 171.5 during the half. As bad as that result is, it is much improved from 299.6 percent during the first quarter and 237.3 during the first half of 2008. According to ISO, exclusion of the mortgage and financial guaranty segment knocks 1.4 points off the combined ratio, leaving it at 99.5 during the first half. Because the mortgage and financial guaranty segment so profoundly distorted the first-half 2009 underwriting results, the combined ratio of 99.5 (rather than 100.9) is probably the best to use for comparative purposes as most insurers are not involved in this specialized business. ISO also reports that the exclusion of mortgage and financial guaranty insurers raises the industry’s rate of return to 4.5 percent, compared with 2.5 percent when this segment is included.

Catastrophe Losses: A Bit of a Respite

As noted by ISO, insured catastrophe losses totaled $7.5 billion during the first half of 2009, down $3.1 billion or 29.2 percent from $10.6 billion in the first half of 2008. Lower catastrophe losses represent one of the more important few bright spots in the 2009 results, especially after last year’s $26.0 billion in losses which secured 2008’s place as the fourth-most expensive year ever for catastrophe losses (behind 2005, 2004 and 2001). Catastrophe losses have remained tame during the third quarter of 2009 as well, especially given that September is the peak of hurricane season. In September 2008, Hurricane Ike came roared ashore in Texas causing $12.5 billion in insured losses to become the third most expensive hurricane in US history. To date, no hurricane has made landfall during the 2009 hurricane season.

Premium Growth Declines Accelerate as Insurance Demand Succumbs to Deep Recession

Net written premiums declined by 4.8 percent during the second quarter of 2009, the biggest drop in premium since ISO began recording quarterly changes in premium. Overall the decline during the first half was 4.2 percent. The drop is somewhat alarming because it represents a continued acceleration in the pace of premium shrinkage. Premiums dropped by 3.6 percent during the first quarter of 2009. The decline in premium during the first half of 2008 was 0.5 percent. Excluding mortgage and financial guaranty insurers produced a net decline of 3.8 percent, according to ISO. If negative premium growth is sustained through the end of 2009, it would mark the first three-year sequential decline in premiums written since the Great Depression, when industry premiums fell for four consecutive years (1930 through 1933, inclusive) after peaking in 1929. Premiums were held back in part by continued soft market conditions, primarily in commercial lines, which entered its fifth consecutive year in 2009. The economy is also a factor (details below). The nation’s real (i.e., inflation adjusted) gross domestic product (GDP) shrank by more than 3 percent during the first half of the year. Fortunately, the economy once again appears to be growing, albeit it modestly, during the second half of 2009 with real GDP growth of between 2.5 and 3.0 percent expected, according to Blue Chip Economic Indicators.
By late in 2008 and early 2009, the magnitude of rate decreases in most key commercial lines had begun to diminish, but remained in negative territory. Personal lines (auto and home) were seeing small increases on net (low to mid-single digits). Nevertheless, whatever modest gains the industry earned from higher rates were more than offset by economic weakness cutting into the demand for most types of insurance. The weak economy is having a disproportionately large impact on commercial insurers due to rising unemployment (slicing payrolls and eroding the exposure base for workers compensation premiums) and reduced construction, manufacturing, transportation and retailing activity.
While negative premium growth since 2007 primarily reflects soft market (pricing) conditions, the recent acceleration in the decline clearly reflects the corrosive effect of the recession on exposure growth and the demand for insurance. During the second quarter of 2009, the economy shrank by 1.0 percent following a 6.4 percent plunge during the first quarter—the most severe plunge since the first quarter of 1982—and a 5.4 drop in the fourth quarter of 2008. The economic slowdown is taking its toll in a variety of ways in 2009:
  • New Housing Starts: Estimated to drop to 580,000 units in 2009, down72 percentfrom 2.07 million units in 2007. The drop affects home insurers and insurers with books of business serving the construction, contracting and home supply industries.
  • New Car/Light Truck Sales: Expected to drop to 10.4 million vehicles in 2009, down 37 percent from 16.9 million vehicles in 2005. The decline will occur despite the wildly successful “cash for clunkers” program, which sparked the sale of nearly 700,000 vehicles. (Note: the Insurance Information Institute estimates that the program netted auto insurers between $225 and $375 million in net new auto premiums.)
  • Employment: The average unemployment rate during the first half of 2009 was 8.7 percent, up from 5.3 percent a year earlier. By September the unemployment rate had reached 9.7 percent, the highest reading since August 1983. Increases in unemployment sap payrolls, the exposure base for workers compensation.
  • Industrial Production and Capacity Utilization: Industrial production slumped 19.1 percent during the first quarter of 2009 and 11.4 percent during the second quarter while just 66.6 percent of industrial capacity was utilized. Weakness in both of these metrics indicates less demand for insurance needed in the production process as well on the goods produced.

Impacts of the Economic Crisis on P/C Insurer Policyholders’ Surplus (Capacity/Capital)

Property/casualty insurance is a highly cyclical business. Because the industry’s peak profits in the most recent cycle were achieved in 2006 and 2007, insurers entered the credit crisis and recession from a position of financial strength. Insurers routinely plow back most of their earnings into the business in order to build up their capital positions. The expanded capital cushion not only provides insurers with the necessary resources to pay large-scale catastrophe losses such as Hurricane Katrina ($41.1 billion) or the September 11 terrorist attacks ($32.5 billion), but also helps insurers ride out stock market crashes, credit market turmoil, recessions, inflations and every other sort of economic and financial market disruption. 
That being said, no investor will emerge from the current economic crisis unscathed and in the end there will be a significant impact on insurance industry capacity. Fortunately, the recent turnaround in stock and bond markets is having a favorable impact on asset prices, bolstering policyholder surplus. As noted by ISO and PCI, industry policyholders’ surplus (the industry’s primary measure of capacity—akin to net worth in other industries) increased by $25.9 billion or 5.9 percent to $463.0 billion during the second quarter from $437.1 at the end of the first quarter. The reversal is both important and timely. Property/casualty insurance industry capacity had plunged by an alarming $84.7 billion or 16.2 percent over the previous five quarters from the pre-crisis peak of $521.8 at the end of the second quarter of 2007. Despite the turnaround during the second quarter, industry capacity remains 11.2 percent below its 2007 peak.
The diminution of capital, combined with reduced investment earnings, implies that insurers will need to be very disciplined in their underwriting if they hope to earn risk appropriate rates of return. In effect, this involves a return to the way property/casualty insurance companies were managed for many decades before the era of high interest rates began in the mid-1970s. Prior to that time insurers managed their operations with the intent of earning underwriting profits every year and were generally successful at doing so in most. Investment earnings were considered helpful but were certainly not viewed as a reliable source of significant earnings.
Despite the erosion of capital over the past two years, the property/casualty insurance industry ended the first half well capitalized by historical standards. The ratio of annualized first- half premiums written to available surplus (a simple measure of financial leverage) stood at 0.92 as of June 30. This means that insurers had $1 in capital (surplus) on hand for every $0.92 in premium written. This compares to an average ratio of 1.52 during the past 50 years.

Impact of the Global Financial Crisis on Catastrophe Risk Funding

Although current levels of capitalization suggest industry strength remains intact and the basic function of P/C insurance—the transfer of risk from client to insurer (and insurer to reinsurer) remains intact, the ability of (re)insurers to raise capital following a “capital event” (e.g., a major catastrophe) is something worth considering in light of the global financial crisis which has dramatically reduced access to capital for all industries. Indeed, the capital intensive nature of catastrophe risk funding was clearly disrupted more than is generally appreciated. Primary and reinsurer capacity in the United States and Europe fell by 15 to 17 percent within the first year of the crisis and most measures of capital adequacy continued to deteriorate through early 2009. Though not viewed as solvency threatening, the industry’s ability to quickly attract and retain capital at reasonable cost following a major capital event was clearly been impacted.  The cost of capital is unquestionably higher reflecting both the scarcity of capital and increased risk aversion among potential investors. Moreover, the crisis revealed that, contrary to conventional wisdom, the securitization of catastrophic risk through catastrophe bonds is not immune to or uncorrelated with the economic forces impacting traditional financial instruments. The global credit crisis has also exposed weaknesses in the catastrophe funding models for various government-run “insurance” schemes, especially in Florida, where the state has exposed itself to the point of self ruin. A detailed discussion of the economics of catastrophe risk funding amid the global financial crisis is available at www.iii.org/Presentations/AonHazardsSummit092109/.   

Financial Strength: P/C Insurer Financial Strength Remains Strong

Additional evidence of strength and resilience in the property/casualty insurance industry comes from recent data on financial impairments of insurers. According to A.M. Best, seven P/C insurers became impaired in 2008. The corresponding impairment rate is 0.23 percent, the second lowest on record—second only to the record low of 0.17 percent set in 2007. All of the impairments in 2008 were of tiny companies, whose business mix bears little resemblance to that of the industry overall. Among the impaired insurers were three title insurance companies, a Texas-only auto and home insurer pushed over the edge by Hurricane Ike and a risk retention group established to handle liability risks of a trucking company. Impairment rates have remained low through the first half of 2009, compared to an accelerating number of bank failures.


A volatile investment environment and shrinking economy had a significant impact on the financial and underwriting performance of the P/C insurance industry during the first half of 2009. A return to profitability and rising capacity during the half are primarily attributable to improved investment market performance. At the same time, persistent soft market conditions and a deep recession severely impacted growth. While insurers remain cautious about the economy and financial market conditions, there is guarded optimism that both will continue to improve as the industry moves toward 2010.
Fundamentally, the property/casualty insurance industry remains quite strong financially, with capital adequacy ratios remaining high relative to long-term historical averages.

A detailed industry income statement for the first half of 2009 follows:

     First Half 2009 Financial Results* --($ Billions)--



Net Earned Premiums




Incurred Losses


            (Including loss adjustment expenses)








Policyholder Dividends




Net Underwriting Gain (Loss)




Investment Income




Other Items




Pre-Tax Operating Gain




Realized Capital Gains (Losses)




Pre-Tax Income








Net After-Tax Income




Surplus (End of Period)




Combined Ratio



*Figures may not add to totals due to rounding. Calculations in text based on unrounded figures.

**Includes mortgage and financial guaranty insurers. Excluding these insurers the combined ratio was 99.5.



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